Mike's Taxes

Research on Safe Withdrawal Rates

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JWR1945
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Mike's Taxes

Post by JWR1945 »

I am hoping that others will assist Mike with tax guidance. The problem is that most of his retirement funds will be in taxable accounts. Refer to Mike response to A Bright Future.
http://nofeeboards.com/boards/viewtopic ... 016#p21016

Mike has been focused on inflation and what it does to investors. If he were to buy long-term TIPS (as I have suggested in A Bright Future) he would have to pay taxes on the adjustments to principal caused by inflation. For example, if he were to start with $1.0 million in long-term TIPS with a 2.5% yield to maturity, he could withdraw $40K per year before taxes for 38.5 years. Part of the $40K would be a return of capital and part of it would be taxable as interest. But if inflation were 3% to 5%, the principal amount would increase by $30K to $50K if there were no premium on bonds prices. The actual increase would most likely be in the neighborhood of $20K to $40K. If Mike's marginal tax rate were 25%, he would have to pay $5K to $10K just because of inflation.

Mike is currently planning to use a very low withdrawal rate, of the order of 1%, depending upon stock dividends. He has responded favorably to John Bogle's recommendation to buy 15 to 20 individual stocks (following John Bogle's guidelines) instead of an index fund because of the tax advantages. (Refer to From Chapter 13.) He is very much aware that he cannot depend upon capital appreciation. It seems to me that Mike has to have better choices. My guess is that even things like annuities or, at least, low-cost annuities are better.

Please provide whatever assistance that you can.

Have fun.

John R.
Mike
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Post by Mike »

My guess is that even things like annuities or, at least, low-cost annuities are better.
Thank you John. Are you thinking inflation adjusted fixed annuities, or a variable annuity with TIPS in it for the tax deferral?
JWR1945
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Post by JWR1945 »

Mike wrote:Are you thinking inflation adjusted fixed annuities, or a variable annuity with TIPS in it for the tax deferral?
I am generally ignorant about annuities.

I know that they can get around your tax problem with the adjustment of TIPS principal as a result of inflation. They are taxed as if they provided interest plus a return of capital, similar to a traditional IRA. Those that are invested in stocks do not pass along any long-term capital gains.

I was thinking about a standard annuity with increasing payments that match inflation.

The biggest complaints about annuities have been their high costs and abusive sales tactics (such as recommending the sale of an older annuity for a new annuity while there is still a surrender fee simply to generate a commission). In addition, there are a lot of products that offer minor differences (distinctions with very little of value) but which make the selection process difficult.

I have seen many recommendations to choose from two low cost providers. One of them is Vanguard. I think that the other is TIAA-CREF, but I am not sure.

Even if an annuity proves to be a poor investment choice for most people, I anticipate that you will be able to double your income (now below 1% of your initial balance) and keep half of your nest egg available in other investments.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

For Mike:

Here are some numbers from www.vanguard.com for a fixed income annuity with rising payments.

I set the birthday to 11201945. I selected Male, Florida, Non-qualified money (i.e., from previously taxed funds), Life Only with payments starting in 01012005.

To get $1000 per month plus 3% per year costs $219479.48.
To get $1000 per month plus 5% per year costs $282971.05.

With a female survivor born on 01011946 (joint plus survivor) with a 75% benefit to the surviving spouse:

To get $1000 per month plus 3% per year costs $254558.40.
To get $1000 per month plus 5% per year costs $338549.52.

The return of capital was in the neighborhood of 50%.

To help you interpret these numbers: $1000 per month is 5% of $240000 per year.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

For Mike:

Here are some more numbers from www.vanguard.com for a fixed income annuity with rising payments.

These are the numbers to use if you are 10 years younger than I am. (I turn 59 later this year.)

I set the birthday to 11201955. I selected Male, Florida, Non-qualified money (i.e., from previously taxed funds), Life Only with payments starting in 01012005.

To get $1000 per month plus 3% per year for life costs $271469.83. Excluded from taxes is 39.2%.
To get $1000 per month plus 5% per year for life costs $375247.66. Excluded from taxes is 36.8%.

With a female survivor born on 01011956 (joint plus survivor payments for life) with a 75% benefit to the surviving spouse:

To get $1000 per month plus 3% per year costs $303411.43. Excluded from taxes is 35.0%.
To get $1000 per month plus 5% per year costs $434070.26. Excluded from taxes is 31.7%.

To help you interpret these numbers: $1000 per month is $12000 per year, which is 4% of $300000 each year.

These numbers should provide you with a good starting point. They are not meant to be the end result. For example, you might purchase a fixed annuity with annual increases of 3% from your taxable accounts and use your tax sheltered assets for additional growth just in case inflation rises above 3%.

Have fun.

John R.
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Post by Mike »

I found out that annuity pay out tends to vary with current interest rates (the insurance company invests the money mostly in bonds), and age. This would seem to make the entry point important, as you are irrevocably locking in the yield at the prevelant interest rates. The lack of a true inflation adjust is a bit unsettling, as it was double digit inflation during the 70s that made the 60s the worst time to retire in the history of the United States. Your suggestion to supplement the annuity with the IRA to compensate for potential high inflation is worth considering. Thank you for the food for thought John. I will ponder this some more.
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Post by Mike »

I think my #1 concern with annuities is that they depend upon the health of the issuing insurance company. Will this company still be in business in 40 years, and faithfully paying the 5% simulated inflation adjust? This is not the same as buying a full faith and credit bond from the US government. There are a motley collection of state insurance pools that have a history of backing up part of the claims when an insurance company goes bankrupt, but state insurance's performance during the S&L debacle gives pause. It appears that if the insurance industry falls on general hard times, there is not enough in the state pools to meet the claims. Buying an annuity requires extremely careful checking of the issuing insurance company. Vanguard seems to currently offer products from Jefferson Pilot, and changes vendors occasionally. Vanguard itself does not appear to guarantee that Jefferson will make all payments into the future.

I have to ask myself the question, it it is unsafe to put a substantial portion of one's portfolio in one individual stock (or 2 to 3), why is it safe to put a significant portion of the portfolio into a product that depends upon the health of the issuing company? I can see that if I do decide to buy an annuity, I will have to do extensive checking into the health of the issuing companies.

It would be nice if there was a federal FDIC type of coverage, or if one could just buy an inflation adjusted annuity from the US government that incorporated the full faith and credit guarantee. This type of service does not appear to exist today.
JWR1945
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Post by JWR1945 »

Mike wrote:This would seem to make the entry point important, as you are irrevocably locking in the yield at the prevalent interest rates.
IMHO, it is probably best to divide your purchases, especially now since we expect interest rates to rise soon.

This is also consistent with buying from more than one company.

Have fun.

John R.
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